2022 (4) TMI 816 - AAR - GST

Levy of GST - liquidated damages/penalties received by the applicant - price adjustment to the main supply or not - supply under CGST Act - HELD THAT - When the parties to a contract specify the time for its performance, it is expected that either party will perform his obligation at the stipulated time. But if one of them fails to do so, the question arises what is the effect upon the contract. A combined reading of the provisions (1) (3) of Section 55 of the Indian Contract Act, 1872 reveals that a failure to perform the contract at the agreed time renders it voidable at the option of the opposite party and alternatively such party can recover compensation for such loss occasioned by non-performance - Section 73 74 of the Indian Contract Act enables recipient of supplies under a contract to be compensated with damages for breach of any provision of the contract. In the present case, Liquidated damages are claimed by the applicant from the contractor due to the delay in performance of the contract, beyond the date prescribed in such contract by the contractor. Similarly, penalties are fixed for breach of the provisions of the contract. These amounts are consideration for tolerating an act or a situation arising out of the contractual obligation - Further Section 2(31)(b) of the CGST Act mentions that consideration in relation to the supply of goods or services or both includes the monetary value of an act of forbearance. Therefore such a toleration of an act or a situation under an agreement constitutes supply of service and the consideration or monetary value is exigible to tax. The Consideration received for such forbearance is taxable under CGST and SGST @9% each under the chapter head 9997 at serial no. 35 of Notification No.11/2017- Central/State tax rate.

Summary

Issues:
1. Whether liquidated damages/penalties received by the applicant constitute consideration exigible to tax under GST or should be treated as a price adjustment to the main supply?

Analysis:

Issue 1: Liquidated Damages and Penalties Taxability under GST

The applicant, a coal company, sought an advance ruling on the taxability of liquidated damages and penalties received from contractors for lapses in contract performance. The applicant argued that such amounts should not be subject to GST as they were price adjustments. The Authority for Advance Ruling analyzed the scenario in light of relevant legal provisions.

Legal Interpretation:

The Authority examined the nature of liquidated damages and penalties, which were imposed on contractors for delays, underperformance, and breaches of contract terms. Referring to Section 55 of the Indian Contract Act, 1872, the Authority highlighted that failure to perform a contract at the agreed time renders it voidable, allowing for compensation for losses incurred due to non-performance.

Consideration as Supply of Service:

The Authority determined that the liquidated damages and penalties were consideration for tolerating acts or situations arising from contractual obligations. Citing Entry 5(e) of Schedule II to the CGST Act, the Authority classified such forbearance as a supply of service. Additionally, Section 2(31)(b) of the CGST Act specified that consideration includes the monetary value of forbearance, making it subject to tax.

Tax Implications:

Consequently, the Authority ruled that the consideration received for tolerating acts or situations under the contract was taxable under both CGST and SGST at a rate of 9% each. The ruling clarified that liquidated damages and penalties for breaches of contract conditions were indeed exigible to GST, contrary to the applicant's contention of being mere price adjustments.

Conclusion:

In conclusion, the Authority for Advance Ruling determined that liquidated damages and penalties received by the applicant from contractors for breaches of contract conditions constituted consideration subject to taxation under the CGST and SGST Acts. The ruling emphasized the legal interpretation of contractual obligations, forbearance, and the tax implications of such transactions under the GST framework.